Economic Fluctuations and the Role of Monetary Policy: An Investigation of an Agent-based Model

Abstract

The merit of ABM comes directly from removing set of unreal assumptions that are commonly assumed in standard models. Not only can ABM regenerates macroeconomics regularities at the same level as the traditional models without introducing any exogenous process but also displays the ability to capture microeconomics dynamics. Simulation results conform to standard monetary economics theory—expansionary monetary policy can be used as a stabilization tool and leave no permanent impacts to real variables. When an economy experiences growth, an increase in money supply is required to stabilize price level, otherwise, severe deflation is expected as well as high fluctuations in unemployment level. Simple monetary policy can be used to stabilize such fluctuations and would reduced economy-wide default risk, which may have positive economic impacts in the long run. Provided that agents do not hold assets in this model setup, the study supports Friedman’s K-percent rule as it performs the best in term of output improvement. The asymmetric effects of monetary policy are found in number of aspects: impact to GDP, impact duration, and impact to unemployment level. Less flexibility in downward price adjustment is the reason behind such asymmetric responses.